11/18/2010 @ 4:47PM

Apple, Mobile Internet and Tech's Latest Wealth-Creating Cycle

This is the first in a series of articles that will focus on companies in the mobile sphere.

Last week’s Open Mobile Summit in San Francisco provided a forum for discussion of ideas, trends and considerations for business models in the mobile Internet and smartphone markets. The dominant conclusions: Business models are in flux, the environment is dynamic and questions on how to monetize mobile apps prevail.

But despite the uncertain shape of the industry at present, it’s clear that the evolution from Internet to mobile Internet will be far more profound than the evolution from the brick-and-mortar economy to the Internet. Mobile Internet is the latest in a series of expanding tech cycles, and will have far-reaching impact on business models, industries and markets.

The first massive and disruptive tech cycle was initiated in the 1970s, when the mass commercialization of the
Intel
x86 chip gave birth to both the personal computer and the
Microsoft
software that drove its adoption. That same cycle also established the pattern for enormous wealth creation–wealth creation that can be partially measured by the stock appreciation of Intel and Microsoft. Beginning in 1985 for Intel and 1986 for Microsoft, the companies’ market caps increased 10 and 7 times respectively by 1990, as PCs proliferated. Double-digit billions were created in the first wave.

The second cycle was widespread adoption of the Internet. As the Internet took off from 1990 to January 1998–a time period chosen to remove bubble effects–Intel’s share price increased from an adjusted $0.68 to $18.68, and Microsoft’s share price increased from $1.23 to $20.25, or up 2500% and 1500% respectively. Roughly $500 billion of wealth was created between the two companies. New companies with new business models sprung up, seizing the newfound opportunity brought by the web. From 2001 to 2008, Amazon,
Yahoo
,
Google
combined created over $150 billion in wealth.

Now we find ourselves here, in the third cycle. Mobile Internet is huge. And, shockingly, it’s still in its nascent phase. The numbers, already impressive, are poised to explode over the course of the next decade. 1.2 billion devices are connected to the Internet today, according to Gartner; by 2020, the number of connected devices will increase to 20 billion. The International Data Corporation reports that 1.3 billion handsets will be sold this year, 19% of which will be smartphones; in two years, smartphone penetration will increase to 25%. Machine to machine (M2M) connections will increase from 82 million last year to 428 million in 2014. More and more non-phone devices (cars, appliances, machines) are connecting to the Internet wirelessly, billions of apps are being downloaded, and streaming video is undergoing astronomical growth. There are more cellphones than personal computers, automobiles and televisions combined.

The hype and hope of mobile Internet access have been around for a long time. And we’ve been through the phase where the initial funding of startups exploded and failed before the foundation was laid for mass adoption. Mobile went through a false start because the carriers decided what would be offered to the customer, telecomm giants resisted Internet protocol, and handsets were clunky. Carriers had little competition and recurring revenues.

Today, thanks in large part to
Apple
. the balance of power between carrier, handset manufacturer, software developer and customer has changed. Apple’s apps model has shifted user experience and customer/provider relationship, substantially diminishing the power of the carrier. Other changes are afoot too. Phone number portability has substantially lowered the hassle costs of switching among carriers for customers.

Apple’s appealing form factors, elegant software, operating system and applications have pushed customers to expect more from mobile Internet devices than clunky operating systems and far-from-intuitive application layers. And following the trend outlined by Moore’s Law–which describes the continuous improvement of technology at the same cost–mobile hardware itself can now deliver more services while on the run. For most people, the smartphone in their pocket today has more computing power than their desktop computer did five years ago. Soon,
Qualcomm
will introduce dual-core Snapdragon processors for your handset. Dual-core chips were introduced for PCs just five years ago.

Each of the three aforementioned tech cycles has been disruptive, changing the industries’ landscapes and creating wealth. Additionally, each cycle has been more compressed and offered greater wealth creation than the last. In information technology, mainframes and
IBM
dominated from the 1950s until minicomputing emerged in the 1970s, led by Digital Equipment Corporation. Minicomputers gave way to PCs in the mid-1980s as Intel and Microsoft rose. Personal computing gave way to the Internet in the mid-1990s and boosted AOL, Yahoo, Amazon and Google into everyday life. Now mobile devices allow Internet access anywhere at any time and are radically changing the landscape.

Riding alongside these cycles, wireless telecommunications evolved similarly over the years before converging with tech in the form of the mobile web.
Motorola
introduced the first handheld cellular phone in 1973, based on 1G or analog transmission (voice only). 2G (SMS messaging) was introduced in 1992, giving rise to a new telecommunications protocol that used data packets and Qualcomm. Since 1992, Qualcomm has delivered over $75 billion in value. In 1996, an outsider to the telecommunications community,
Research in Motion
, expanded on messaging communication, eventually developing into a market leader with its BlackBerry smartphones. RIM’s stock appreciated roughly 100 times from an adjusted $0.73 in 1998 to around $70 in June 2007, when the Apple iPhone was introduced. By utilizing the new technology to deliver communication differently, Research in Motion created approximately $36B in market cap.

The move from 2G to 3G mobile Internet took the next ten years, or from 1992 to 2002. With 3G–which enabled and improved broadband and web page transmission–the traditional landscape for handset manufacturers shifted from
Nokia
,
Ericsson
and Motorola to Apple, Google and Research in Motion. The wealth shifted too; Nokia, Ericsson and Motorola lost approximately $280B in market capitalization during the same time Apple, Google and Research in Motion created $490B. Now 4G is available and will create new opportunities.

Each technology cycle has created enormous wealth and produced a new class of market leaders. Mobile Internet is still in the early stages of evolution and promises to challenge existing business models. The wealth creation and potential destruction will present opportunities, just as they have in the previous cycles.

So what does this mean for your investments? The first observation worth noting is that Apple has been the game changer of mobile Internet, and remains central to the development of the industry. Apple did not present at Open Mobile Summit, yet it was referenced at each panel because Apple has been the marquee player in establishing mobile application frameworks and encouraging adoption. Apple is the “closed” system for which others are trying to develop–and which others are trying to emulate. Ironically, while listening to a panel speaking about how iPads will be used, my entire row of 12 people were working on their iPads.

Apple introduced the one of the first examples of consumer technology as a service, with the iTunes/iPod system, creating the blueprint for the resulting iPhone/App success. Apple’s system changed consumer behavior toward music (read: digital media) consumption. Apple replicated that system in the iPhone/App system by changing consumer expectations regarding what their cellphone could do, consequently upsetting the balance of power between carrier and handset manufacturer.

Apple has extended the system to iPads and will soon do the same with their iMac and MacBook lines, bringing apps to desktop and laptops as well. In fact, while most investors have focused on Apple as a superb device manufacturer, investors should instead think about how Apple has been able to disrupt business models, and what that might mean–both for Apple and for its competitors–in the context of mobile Internet’s evolution. For example, what happens to search when people have apps on their desktop, laptop, tablet and smartphone?

As long as Apple remains the industry innovator and Steve Jobs remains healthy, (both true today), Apple is an attractive stock at current prices. Trading at around $309 today, the stock would appreciate 30% over one year if it reaches the price target of $400, at which price its FY2012 non-cash price-earnings growth ratio would be 1.0. Today the non-cash price-earnings growth ratio is 1.3.